What is a pair trading strategy

Trading pairs is not a risk-free strategy. Trading pairs is not a risk-free strategy. To achieve spread stationarity in the context of pairs trading, where the portfolios only consist of two stocks, one can attempt to find a cointegration irregularities between the two stock price series who generally show stationary correlation.

Retrieved 20 What is a pair trading strategy Dealing with such adverse situations requires strict risk management rules, which have the trader exit an unprofitable trade as soon as the original setup—a bet for reversion to the mean—has been invalidated. If the price of Pepsi rose to close that gap in price, the trader would make money on the Pepsi stock, while if the price of Coca Cola fell, he would make money on having shorted the Coca Cola stock.

While it is commonly agreed that individual stock prices are difficult to forecast, there is evidence suggesting that it may be possible to forecast the price—the spread series—of certain stock portfolios. If the price of Coca Cola were to go up a significant amount while Pepsi stayed the same, a what is a pair trading strategy trader would buy Pepsi stock and sell Coca Cola stock, assuming that the two companies would later return to their historical balance point. Pairs trading strategy demands good position sizing, market timingand decision making skill. The reason for the deviated stock to come back to original value is itself an assumption.

When the correlation between the two securities temporarily weakens, i. What is a pair trading strategy, the two companies have shared similar dips and highs, depending on the soda pop market. This irregularity is assumed to be bridged soon and forecasts are made in the opposite nature of the irregularity. If the price of Coca Cola were to go up a significant amount while Pepsi stayed the same, a pairs trader would buy Pepsi stock and sell Coca Cola stock, assuming that the two companies would later return to their historical balance point.

What is a pair trading strategy Read Edit View history. The strategy monitors performance of two historically correlated securities. Proceedings of the American Control Conference, If the price of Coca Cola were to go up a significant amount while Pepsi stayed the same, a pairs trader would buy Pepsi stock and sell Coca Cola stock, assuming that the two companies would later return to their historical balance point.

When the correlation between the two securities temporarily weakens, i. Views Read Edit View history. These strategies are typically built around models what is a pair trading strategy define the spread based on historical data mining and analysis. A common way to attempt this is by constructing the portfolio such that the spread series is a stationary process. It is assumed that the pair will have similar business idea as in the past during the holding period of the stock.

A notable pairs trader was hedge fund Long-Term Capital Management. The strategy monitors performance of two historically correlated securities. Historically, the two companies have shared similar dips and highs, depending on the soda pop market.

When the correlation between the two securities temporarily weakens, i. Karlsruhe Institute of Technology. Monash University, Working Paper. They have found that the distance and co-integration methods result in significant alphas and similar performance, but their profits have decreased over time.

They have found that the distance and co-integration methods result in significant alphas and similar performance, but their profits have decreased over time. When the correlation between the two securities temporarily weakens, i. Karlsruhe Institute of Technology. Retrieved from " https: This irregularity is assumed to be bridged soon and forecasts are made in the opposite nature of the irregularity.